As Greece, and now Spain and Italy, struggle with the crushing burden of debt brought on by the modern welfare state, perhaps we should shift our gaze some 1,200 miles north to see how austerity can actually work.

Exhibit #1 is Estonia. This small Baltic nation recently had a spate of notoriety when its president, Toomas Ilves, got into a Twitter debate with Paul Krugman over the country's austerity policies. Krugman sneered at Estonia as the "poster child for austerity defenders," remarking of the nation’s recovery from recession, "this is what passes for economic triumph?" In return, President Ilves criticized Krugman as “smug, overbearing, and patronizing.”

Twitter-borne tit-for-tat aside, here are the facts: Estonia had been one of the showcases for free-market economic policies and had been growing steadily until the 2008 economic crisis burst a debt-fueled property bubble, shut off credit flows, and curbed export demand, plunging the country into a severe economic downturn.

However, instead of increasing government spending in hopes of stimulating the economy, as Krugman has urged, the Estonians rejected Keynesianism in favor of genuine austerity. Among other measures, the Estonian government cut public-sector wages by 10 percent, gradually raised the retirement age from 61 to 65 by 2026, reduced eligibility for health benefits, and liberalized the country’s labor market, making it easier for businesses to hire and fire workers.

Estonia did unfortunately enact a small increase in its value-added tax, but it deliberately kept taxes low on businesses, investors, and entrepreneurs, refusing to make changes to its flat 21 percent income tax. In fact, the government has put in place plans to reduce the income tax to 20 percent by 2015.

Today, Estonia is actually running a budget surplus. Its national debt is 6 percent of GDP. By comparison, Greece’s is 159 percent of GDP. Ours is 102 percent.

Economic growth has been a robust 7.6 percent, the best in the EU. And, although the unemployment rate remains too high, at 11.7 percent, that is down from 19 percent during the worst of the recession. It’s hard to see how a Krugman-style stimulus would have done much better.

Next door, Latvia has also embarked on a successful austerity program. In 2008, facing a deep recession — the worst in Europe, with a 24 percent drop in GDP from 2007 to 2009 — and a run on the country’s largest bank, Latvia turned to Europe for a €7.5 billion bailout. But unlike Greece and other countries that seem to look at such assistance as a form of permanent welfare payment, Latvia used the EU loan as an opportunity to make the painful government reforms necessary to restore long-term economic health.

Latvia embarked on the toughest budget cuts in Europe. Half of all government-run agencies were eliminated, the number of public employees was reduced by a third, and public-sector wages were slashed by an average of 25 percent.

In the end, Latvia borrowed just €4.4 billion of the available €7.5 billion, and its economy is on the rebound. Unemployment, which reached 19 percent at the height of the recession, has declined to around 15 percent. Real GDP growth was 5.5 percent last year, Canada and is expected to be at least 3.5 percent this year. This year’s budget deficit will be just 1.2 percent of GDP, and the national debt is just 37 percent of GDP and declining. The credit-rating agencies recently upgraded the country’s credit-worthiness. And, while Greece mulls leaving the euro zone, Latvia has been pronounced eligible for membership.

The third Baltic country, Lithuania, also dramatically cut government spending  as much as 30 percent in nominal terms  including reductions in public-sector wages of 20 to 30 percent and pension cuts of as much as 11 percent. Unfortunately, Lithuania may have undermined the effects of those cuts by also raising taxes, including a significant hike in corporate taxes. Still, Lithuania is expected to see its economy grow by 2.2 percent this year.

Krugman and others do have a point in saying that the Baltic countries benefit from strong trade opportunities with neighbors such as Sweden and Finland that have growing economies. And it is true that, while their recoveries have been strong, none of the Baltic countries is expected to fully return to pre-recession levels of prosperity until 2014 at the earliest. On the other hand, when are Greece, Spain, or for that matter the United States  none of which has done much if anything to reduce government spending  likely to return to pre-recession growth?

If the Baltics are not a sufficient example of the value of cutting government, we can look a bit to the west, to Switzerland. Switzerlands constitution includes provisions that limit the countrys ability both to run debt (the growth in government spending can be no higher than average revenue growth, calculated over a multi-year period) and to increase taxes (taxes can be increased only by a double-majority referendum, meaning that a majority of voters in a majority of cantons would have to approve the increase).

As a result, total government spending in Switzerland at all levels of government is just 34 percent of GDP, compared to an average of 52 percent in the EU, and more than 41 percent in the United States. Switzerlands national debt is just 41 percent of GDP and shrinking at a time when other European countries are becoming more insolvent. Switzerlands economic growth has not yet returned to pre-recession levels, but it is better than the growth in, say, Greece or Spain. And its unemployment rate is just 3.1 percent, the lowest in Europe. If thats not enough evidence, we can just look to our own neighbor Canada. The Canadian federal government has been reducing spending in real terms since the 1990s. As a result, federal spending as a share of GDP has fallen from 22 percent in 1995 to just 15.9 percent today. Compare that to the United States, where the federal government spends 24 percent of GDP, roughly half again as much. And, while Canadian provincial governments spend appreciably more than do most U.S. states, total government spending at all levels in Canada has declined from 53 percent in the 1990s to just 42 percent today  still far too high, but clearly moving in the right direction.

Canada has also cut taxes. Corporate tax rates at the federal level were slashed from 29 percent in 2000 to 15 percent today, less than half the U.S. federal rate. Capital-gains taxes were also cut, as were, to a lesser degree, income taxes.

When Canada  led for so long by the ultra-liberal Pierre Trudeau  has smaller government and lower taxes than the U.S., something is seriously out of whack.

As a result of these changes, Canadas national debt is now less than 34 percent of GDP. Its budget deficit this year will be just 3.5 percent of GDP, while ours will be 8.3 percent. Canadas economy will grow at 2.6 percent this year  a modest rate but faster than ours  and its unemployment rate is 7.3 percent, again better than ours.

All these countries are following the successful examples set by other nations such as Chile, Ireland, and New Zealand in the 1980s and 90s, and Slovakia from 2000 to 2003.

Of course, none of these examples is perfect, and cuts in government spending will not, by themselves, cure all ills. These countries often benefited from circumstances aside from fiscal discipline. Still, the evidence is there. Cutting government spending, reducing taxes, and liberalizing labor markets brings more economic growth, increased employment, less debt, and more prosperity. The opposite is also true: Bigger government and higher taxes result in more economic misery  see Greece, Spain, etc.

As the United States looks to its future, it is time to decide which path we will follow.

 Michael Tanner is a senior fellow at the Cato Institute and the author of Leviathan on the Right: How Big-Government Conservatism Brought Down the Republican Revolution.

in the case of Estonia and Latvia, having your own currency and a monetary policy away from the ECB sure helps things... Lithuania as a member of the EMU is still fully vested in whatever tragedy the shared currency yields.
While economic theory can be argued till the aurochs come home, the lowest common denominator in the economic crisis is the Euro. It is the akin to the virus or bacteria that would develop into a plague. Instead of mediteranean Merchant ships transporting rats infested with fleas, the spanish banks and derrivitive instruments have transported the Euro virus around the globe.

One wonders if Mr. Krugman has ever run a successful business, or even attempted to start one, or had to hire or fire an employee; or make investments based upon the real world and not the Alice-In-Wonderland world of economics based upon government intervention and taxation, or had the responsibility of running a local government without the power of the printing press.

One wonders if Mr. Krugman has ever run a successful business, or even attempted to start one, or had to hire or fire an employee; or make investments based upon the real world and not the Alice-In-Wonderland world of economics based upon government intervention and taxation, or had the responsibility of running a local government without the power of the printing press.

Latvia embarked on the toughest budget cuts in Europe. Half of all government-run agencies were eliminated, the number of public employees was reduced by a third, and public-sector wages were slashed by an average of 25 percent.

What they mean is austerity for the government, rather than the country as a whole. The best policy for any country is economic growth.

6
posted on 06/20/2012 5:16:39 AM PDT
by Moonman62
(The US has become a government with a country, rather than a country with a government.)

A High School Senior at a Private School or Charter School knows more about Economics than Paul Krugman.

Krugman's knowledge is very specialized in the area of international trade and he has a Nobel prize for it. He seems to be a complete moron concerning domestic economics, which is what he most frequently comments on.

8
posted on 06/20/2012 5:25:58 AM PDT
by Moonman62
(The US has become a government with a country, rather than a country with a government.)

I’m tired of hearing about this “austerity measures” crap!! Who came up with this muddled, pansy term?? Probably some mealy-mouth like Alan Greenspan. It’s called staying within your means, not spending more than you take in. An old-fashioned virtue that has always worked and leads to prosperity. “if costs are right, profits will follow” Andrew Carnegie said. Industry and frugality lead to success in every instance. Only liberals would be against thrift, because that limits profits and promotes indolence.

I couldn’t agree more about the use of the word “austerity.” That has irked me since I first heard it ages ago. Since when is it “austere” to live within your means? Yet another case of libs controlling the language and the debate.

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